Question

1. Tim Horton's is considering a project to make jumbo jets. Should Tim's undertake the project? The following data may be useful. .Tim's has a target D/E of 0.6. Tim's current beta is 11 . Boeing has a D/E of 1.2 and a beta of 2.1 . Assume the risk free rate is 4% and the market risk premium is 6%. .The project will cost $1 billion, and will generate EBIT of $175 million Assume the entire project cost will consist of assets which will be eligible for CCA with a CCA rate of 20%. Assume the project will run indefinitely Tim's planning to finance this project at the same D/E level that the company currently enjoys. and assume that both firms can borrow at 5%. All firms pay tax at a rate of 25%. · .

Answer 1

		Cost of capital for TIM
		Required Return on Equity =RiskFree Rate +Beta*Market RiskPremium
		Required Return on Equity =4+1.1*6	10.6%
		D/E=0.6 , D=0.6E
		Total Capital =E+0.6E=1.6E
	Wd	Weight of Debt =0.6E/1.6E=	0.375
	We	Weight of Equity =E/1.6E=	0.625
	Ce	Cost of Equity =Required Return=	10.6%
	Cd	After tax cost of debt =5*(1-0.25)=	3.75%
	WACC=Wd*Cd+We*Ce	Weighted Average Cost of capital(WACC)	8.03%
		Cost of capital for Boeing
		Required Return on Equity =RiskFree Rate +Beta*Market RiskPremium
		Required Return on Equity =4+2.1*6	16.6%
		D/E=1.2 , D=1.2E
		Total Capital =E+1.2E=2.2E
	Wd	Weight of Debt =1.2E/2.2E=	0.545
	We	Weight of Equity =E/2.2E=	0.455
	Ce	Cost of Equity =Required Return=	16.6%
	Cd	After tax cost of debt =5*(1-0.25)=	3.75%
	WACC=Wd*Cd+We*Ce	Weighted Average Cost of capital(WACC)	9.59%
		CASH FLOW FOR TIM
		Earning Before interest and taxes	$175	million
		Net Operating Profit after taxes (NOPAT)	$131	million	175*(1-0.25)
	PV1	Present value of NOPAT for all future years	$1,634	million	131/0.0803		CASHFLOW FOR TIM Eaming Betore interest and tasos Net Operatng Profit afer taesNOPAT 131 milon 15110.25) Present alue of NOPAT for al futuree $1,634 milion 00803 $176 milion PRESENT VALUE OF DEPRECIATION EXPENSE Yea Asset at the beginning of the t119 10 12 13 15 $287 $218 $1,000 00 $840 200 $160 $800 $40 $186.13 $137.⑩ $10153 $75.18 $55.68 $4123 30.53 $2261 帛伦.74 $12.40 $918 $6.00 5.04 373 $2.76 $2.04 $1.51 $1.12 $0.83 $0.61 $712 $107 $86 瓣 $55 $44, $35 $18 $4 $14 $14 Be A"20% S6 $512 $410 $228 $262 $210 $168 $134 串107 86 $$9 $55 串44 $35 28 23 $412 422 tt66 452 $42 餬 427 $17 $11 $7 φ128 $5 18 14 Asset at the End of the Year million Present Value of Depreoiation Total Present value of Depreciation espe hitial Cash Flow NET PRESENT VALUE Asset t the end De heYear million) 、$ 00 фе 40 $12 SUM D.BM 10003 N) PY2 080ng 712 $1,000) $1,346 ilion Note: Depreciation eepense afer 20jears is negligble Hence we have approsimatedto 20years oniy SHOULDUNDERTAKE THE PRONECT, SINCE NPV IS POSI BOING has higher WACC Hence, NPv for Boing vil be lower